Moving right along on the road to financial security, let’s look at how to best structure your accounts to reach your goals. Grab your balance sheet and let’s get started!

For now, we are going to look specifically at your Cash Flow accounts.

The purpose of your Cash Flow accounts is to hold money that you will be soon spending or investing. Often, this includes checking, savings, and other miscellaneous accounts (change jar, Pay Pal account, and so forth).

Your checking account forms the backbone of your Cash Flow accounts. In my opinion, most twentysomethings, a single checking account is adequate for cash flow needs. In choosing a checking account, look for an account that has no minimum balance fees, allows you to login to check your balance online, and has a local branch where you can deposit or withdraw funds.

The major drawback to a checking account is that unless you maintain a very high balance - in the tens of thousands - it is difficult to find a checking account that earns interest. Any account that doesn’t produce interest in effect loses money for you, as inflation slowly eats away at the purchasing power of that money. Accordingly, you should keep as little money in your checking account as possible - just enough to cover your immediate expenses for the next month.

“What about my savings account?” you may ask. As far as I’m concerned, savings accounts as offered by most banks have no place in a twentysomethings financial picture. Most savings accounts generate pathetic returns, often less than 1% per year….not even enough to keep place with inflation! Accordingly, I don’t recommend that you hold a traditional savings account.

Instead, open an FDIC insured savings account that offers at least a 3% annual return on your money. With a 3% or better return, your money should keep pace with inflation. FDIC insurance is provided by the government and protects your savings up to $100,000 in the event that the bank should fail (as many did during the Great Depression).

Online savings accounts such as the “Orange Account” offered by ING Direct currently yield a (relatively) hefty 4.40%; certainly better than the 0.2% that you can expect from most savings accounts. Another advantage to the ING Direct savings account is that when an existing account holder refers you and you open an account with at least $250, ING will give you an additional $25. That’s a 10% return on your initial investment - not too shabby. If you are interested in opening an ING account, email me (admin@quarterlifefinance.com) and I will send you a referral link.*

Alternately, you could put your savings into a “money market fund.” Money market funds are mutual funds that typically trade at $1 per share and invest in short-term securities, like certificates of deposit. They can be very attractive for short term savings, as they often generate a better return than traditional savings accounts. However, money market funds are investments, not savings, and do not carry FDIC insurance. In other words, if the value of the fund dropped below $1 per share (known as “breaking the buck”) you could lose some of your investment. Is that a real concern? According to Peter Crane, managing editor of the IBC Money Fund Report, no money-market fund has “broken the buck”. Still, if you can earn a comparable return from an FDIC insured account, why not?

Ultimately, this savings account will serve as a place to park money that you will need in the near future, as well as “emergency savings”. This is money that you can’t afford to take risks with, as you may need it at any point. We’ll discuss emergency savings in greater detail in a week or two.

Of course, 4.4% pales in comparison to the double-digit returns that a twentysomething investor can expect out of the stock market. As such, you’ll want the vast majority of your savings to live in long-term investment accounts. We’ll save those for next time!

Action Items:

• Review your checking account. Make sure your account has no minimum balance fees, allows you to login and check your balance online, and has a local branch where you can deposit and withdraw funds. If you don’t have a checking account, go open one!
• Open an interest-bearing savings account, such as the Orange Account from ING Direct, to hold short term and emergency funds.

*Full Disclosure: I currently hold a savings account with ING Direct and have been very pleased with their service. If you take advantage of the aforementioned promotion and open an account with at least $250 via my referral email, you will receive $25 and I will receive $10.

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This entry was posted on Thursday, September 7th, 2006 at 2:11 am and is filed under Promotions, "The Plan". You may e-mail this post to a friend. You may print this page. You can leave a response, or trackback from your own site.